Value Creation and the Lightbulb

By Kash Mansori
Posted: May 06, 2015

Last week the famous (infamous?) BEPS project released a discussion draft on the topic of how activities that create intangibles should be remunerated. According to existing guidelines and practice, when multiple entities work together to create an intangible, each entity is rewarded according to its share of the costs incurred during that process. However, the BEPS group working on this issue is now suggesting that each entity should instead be rewarded based on the “value” it has contributed rather than its share of costs.

In an article in the publication Tax Analysts (subscription required) WTP Advisors’ own Guy Sanschagrin had a few critical comments about this suggestion.

“I have a problem with the overall BEPS approach of focusing on value creation as a way to drive the transfer pricing because I think there is a potential contradiction with the arm’s length standard,” said Sanschagrin.

“Thomas Edison did not invent the light bulb. Somebody else did. What Thomas Edison did was successfully commercialize the light bulb. He set up a system to innovate and organize [research and development] processes. He also led the development of efficient manufacturing processes. He had help from employees – but he led this effort,” Sanschagrin said.

“I think there is a strong potential for double taxation to come of that due to disagreements in terms of the value measurement.”

The Thomas Edison example highlights an important point. Presumably, the BEPS working group would propose that the team assembled by Edison to develop the commercial lightbulb should have received more than their costs (i.e. wages and salaries) because they helped to create something of substantially greater value.

But would that necessarily be more consistent with an arm’s length arrangement, as the BEPS discussion draft argues? Since the salaries paid by Edison to his team were, by definition, arm’s length, it’s hard to see why that would be the case. Of course Edison’s team could have demanded an equity share in his firm in return for their assistance – but individuals frequently provide similar services in the market without making such a demand, and it must be acknowledged that that is also a perfectly valid arm’s length arrangement.

Just as importantly, while it is relatively straightforward to measure cost contributions to the process of developing an intangible it is hard to see how one could arrive at an objective measure of relative “value contributions”. Each interested party, whether a multinational enterprise or any given tax authority, would be likely to simply choose a measure of relative value contributions that suits its wishes. Uncertainty and controversy would be sure to follow.

Transfer pricing has plenty of grey areas as it is, and inventing a lightbulb is in many ways a mysterious process. Adding a significant new element of subjectivity to our evaluation of it seems likely to create far more problems than it might solve.